Bloomberg ) — With U.S. stocks on the rebound, this summer's selloff is looking more like a pause in the bull market than the beginning of its end.
Of course, traders have struggled to predict where the economy is headed — and the recession fears that helped fuel the recent pullback could resurface just as quickly as they faded. Additionally, the US election and geopolitical tensions are adding further elements of uncertainty.
But beneath the surface, there are some reassuring signals. Among them: The selloff hit a relatively small part of the market, where it was nowhere near the breadth of the rout triggered by the Federal Reserve's rate hikes, the pandemic and other major events. And while ratings are at risk of another recalibration if the economy ends up sputtering, the S&P 500 held above a threshold during the recent pullback that — at least to technical analysts — telegraphs continued investor confidence.
Moreover, the benchmark has already recovered all of its August decline and is now just 2.2% away from its mid-July record high.
Contains Selloff
While the slide that began last month was sharp and swift, sending the tech-heavy Nasdaq 100 Index into a technical correction in three weeks, it was driven by a narrow number of stocks.
At its height, only about 5% of S&P 500 members fell to a one-year low, according to data compiled by Bloomberg. This means that the downturn was much more limited in scope than previous ones triggered by major macroeconomic changes. After rising inflation prompted the Fed to aggressively raise rates in 2022, nearly half of the index fell to a 12-month low. The pandemic sent about two-thirds to that level.
Limited withdrawal
Before last month, the S&P 500 had been in it the longest stretch seen a 2% one-day decline since the start of the global financial crisis in 2007. From one perspective, this makes the recovery look overdue.
Unlike the Nasdaq 100 — whose decline reflected lingering concerns about sharp technology valuations — the S&P 500 never dipped into official correction territory, recovering after an 8.5% drop from its peak.
In 2022, the index fell 25% before a steady rebound. And during the global financial crisis, it plunged as much as 57% – and then took four years to fully recover.
Above the main levels
The S&P 500's 200-week moving average has been a strong indicator of the index's level since the turn of the century. Recently, the benchmark bounced back after hitting it during growth fears in 2016, the US-China trade war in 2018 and again in 2022.
This time, it didn't even come close to that threshold even at its lowest point. While this also shows how much further the index could fall in a renewed selloff, it shows that investors were confident enough to get in before the market tested a new bottom.
Japan retreating
Japan was at the center of global turmoil as its tightening monetary policy pushed the yen to one of its strongest levels this year, prompting hedge funds to sell assets to unwind. carry out trade financed by low-cost loans in Japan.
The currency is now easing again as policymakers there quickly reassured markets that further rate hikes were likely off the table. This has also trickled down to stocks in Japan.
Warning sign
On the other hand, the economic risk that the Fed has waited too long to start cutting rates has not gone away. So the recent pullback means more of a soft downside is being priced in, exposing the market to another slide if it turns out to be off base.
One measure of what investors are counting on can be seen in how stocks linked to the economic cycle – or so-called cyclical sectors – are doing compared to their less exposed peers.
In the US, a basket of Goldman Sachs Group Inc. which measures the relative movement between groups, shows that while cyclicals have lagged behind protection recently, they are still priced for an economic expansion.
On Thursday, an unexpectedly large increase in retail sales gave confidence to that view. But earlier figures also showed a cooling of job growth and a decline in activity in the manufacturing sector.
“I'm by no means hitting the panic button here, but compared to other asset classes, the S&P 500 looks very underpriced,” said Matt Stucky, chief equity portfolio manager at Northwestern Mutual Wealth Management.